Real estate investors know they absolutely must cash flow each month or else the investment is probably not a wise choice.finding the right poperty to invest in Unless the investment is a pure flip, where the property is bought and sold within a short period of time, the rate and term for the financing package is an important piece to the positive cash flow puzzle.

Fortunately we’re still experiencing ultra-low mortgage rates which increase monthly profits. Most banks and mortgage companies offer the same suite of loan offerings, primarily a choice between a fixed rate and an adjustable one. For property retention, fixed rates are hands down the best choice in today’s environment. But which rate and at which term?

When considering financing investment property, while the rate is important it’s the loan term, or the amortization period, that should command your most attention. Why? Because the longer the loan term, the lower the monthly payment and conversely the shorter the loan term, the higher the monthly payment. When considering monthly cash flow, shouldn’t the investor simply choose the longest term available to achieve the lowest mortgage payment? Maybe. But there’s a tradeoff when comparing a 15 year and a 30 year fixed rate loan. Yes, the payments on a 30 year mortgage are lower but the cost of funds is much greater. Here’s what I mean.

Consider a $250,000 loan using a 30 year interest rate of 3.75 percent. The principal and interest payment works to $1,157. If the monthly rent on that home is $2,500, there’s $1,343 to pay expenses with the rest going into your bank account.

Now look at a 15 year loan with a rate of 3.25 percent. The monthly payment works to $1,756 leaving just $744 every month. So the 30 year term is the better choice of the two, right? Maybe. But you also have to look at the cost of those funds, the interest, paid on both loans.Say you plan to hold the property for 10 years, how much have you paid and how much would you still owe?

            Interest Paid                     Outstanding Balance

30 yr         $84,214                                 $195,275

15 yr         $57,961                                   $97,161

 

You notice two things right away, don’t you? After 10 years you’ve paid $26,253 more in interest and there’s still $195,275 left on the balance with 15 more years to go. There is indeed a tradeoff. Lower payment for cash flow vs. interest expense.

So which do you choose? Fortunately, it’s not an “either-or” scenario because there is also 20 and 25 year term available. Most banks don’t mention these additional choices but every lender has them in their portfolio of mortgage product. Now let’s look at that same chart using a 3.75 percent rate:

            Interest Paid                       Outstanding Balance

30 yr        $84,214                                   $195,275

25 yr        $80,984                                   $176,744

20 yr        $75,997                                   $135,687

15 yr        $60,849                                    $78,969

 

The payment for the 25 year loan is $1,285 per month and the 20 year mortgage is $1,482 giving you a wider range of options. Yes, the interest rate is certainly a consideration. But the loan term will have the biggest impact on financing costs as well as cash flow.